If you have a credit card and you have been paying on it every month, then chances are you have also been paying interest. Interest rates have historically moved based on what the Federal Treasury Reserve determines what is needed for the time period. They go up and down based on the needs of the economy. Currently, the interest rate is resting at 2.12% interest though it has gone upwards of 14% in the late 1970s.
What are Interest Rates?
Interest rates are the amounts due on a sum of money borrowed or lent. This means the principal sum you needed to buy your home or your car is having a select percentage added to it, compounded at a frequency determined at the time of the loan and applied to your final responsible total every month.
What do they do?
This can also be the amount of money accrued on a savings account or a certificate of deposit (CD) every month, quarter or annually. This is the type of money that is being added to the principal account for allowing the financial institution to access it for the specified time period.
Once the time period is up for the CD or for the loan ends the situation changes. In the CD you can either have the amount rollover with the new money generated added to the account, renegotiate the terms of the loan you are providing to the institution, or remove it. For the loan, you will have either paid it off or you will be talking with the lender about the terms of the loan.
How do they affect my finances?
Interest rates are part of lending and borrowing and how they affect your finances depends on how you are using your money.
- Earned Interest
Lending out money gives you the right to charge interest. This interest is earned interest. It occurs on a set schedule determined by the bank for every month or quarter installments. The bank will pay interest on the amount you loaned them to lend to people. You will be able to watch your account increase in value as they add the money.
- Compound Interest
Compound interest is the interest earned on top of the interest you have already earned. For example, $2,000 is deposited into your savings account with 10 percent simple interest rate. With the basic calculations of $2,000 X .10 = $200 earned on the account in one year. If you are working with a bank, your account will earn interest daily through compounding the interest already applied to the account.
Annual Percentage Yield (APY) on the accounts is determined by the formula (1+r/n)n – 1. N is the number of compounding periods in your year. So figuring out what your APY will be, is determined by the number of periods or days, months, or years compounded on the account.
- Interest Payments
When you borrow money to help pay for a necessity in your life like a new home or a car that you will have to pay interest on the principal amount loaned to you. It is the reverse of the earning money on an account as you are the one with the debt.
- Fixed Interest Rates
An interest rate that is fixed is one that is unchanging. This means that no matter what is happening in the world, the interest rate on your loan will not change. It will remain the same for the duration you have the loan. This is a very secure way to balance a budget as you will always know what your monthly payments will be without getting any surprises like on a variable interest rate.
A fixed-rate will be higher than a variable rate. This is because it is set between the estimated fluctuation rates. These rates are good for consistent payments and are a terrific way to get a lower rate during a time period when the rates are down.
- Variable Interest Rates
Sometimes called adjustable or floating rate this type of rate is one that is more fluid. This means that it can change from month to month depending on the lending institution and the amount borrowed. This can mean your payments will swing wildly from month to month in unstable times.
The advantage of this kind of rate is when the rates fall than the amounts being paid will be lower than the fixed interest rates. This is only temporary though. If the rates go back up then they will end up paying more on their rate.
What is APR?
APR is the Annual Percentage Rate on consumer loans. This is the rate of return you can expect to pay back for the money you borrowed. This is what is found on credit cards or on mortgages. Interest is not compounded daily, weekly, or monthly. It is usually compounded on yearly basis.
The Cost of Debt
As of August of 2019, the interest rate is 2.12%. The Federal Government has been holding the rates down since the recession of 2008. They started letting them come back up in 2015. This means anything purchased between 2009 and 2015 had little to no interest rate applied to the purchase. This also means that any type of long term savings account saw very little money returned to the account if it was lent out.
Historically, the interest rates have not been this low since the 1940s. They gradually are coming back as the economy stabilizes. Keeping the interest rates artificially low has helped many people in financial difficulty stay solvent as well as kept people in their homes. Keeping inflation low is a way to control the money systems as they fluctuate.
Interest rates help control the responsibility of debt. They allow for people to pay back more than they took to their lender as a way for the lender to help others. It is also a way to make money on your own investments by lending out your unneeded cash for a specific time period with the promise of a set return on your investment.